IMPACT OF WORKING CAPITAL MANAGEMENT ON THE PROFITABILITY OF QUOTED NIGERIAN CEMENT COMPANIES. Junaidu Muhammad Kurawa PhD Sunusi Garba

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1 IMPACT OF WORKING CAPITAL MANAGEMENT ON THE PROFITABILITY OF QUOTED NIGERIAN CEMENT COMPANIES Junaidu Muhammad Kurawa PhD Sunusi Garba 1 Department of Accounting Bayero University, Kano-nigeria 2 Bursary Department Federal University Dutse, Jigawa State-nigeria 1 2 Abstract Working Capital management requires making decisions on the amount and composition of the current assets holdings and the means of financing them. This paper investigate the relationship between the variables of working capital management and company profitability with emphasis on quoted Nigerian Cement producing firms from 2001 to 2010, all cement companies that are listed on the Nigerian Stock Exchange form the population of the study. Using a panel data analysis the study employed GLS regression, descriptive statistics, correlation as well as simple graphs as analytical tools. The study discovered that working capital variables of inventory turnover, debtors' collection period, average payment period and the cash conversion cycle significantly affect the profitability of quoted cement companies in Nigeria. For this reason, the companies should significantly raise their level of investment in working capital; such investment in current assets should heavily be concentrated in raw materials and production consumables to improve production and turnover. Keywords: Working Capital Management, Inventory Turnover, Debtors Collection Period, Average Payment Period and Cash Conversion Cycle Introduction Working capital management is an aspect of corporate finance that deals with decisions regarding the flow of required resources to continuously carry out operations. Resources of the firm may be financed through borrowings very much related to the short, medium or long term requirements of trade or business. Efficient management of these short term assets and liabilities is essential as they play an important role in ensuring that businesses continuously operate as going concerns. It is therefore very important for every enterprise to plan for adequate funds to meet the day-to-day expenditure requirements of the business. Working capital management is a process of planning for the acquisition and usage of short term assets and liabilities. Working capital is the flow of readily available funds necessarily required for the continuous operations of an enterprise. Working capital management therefore, is a process of determining the firm's policy in planning for its current assets' and liabilities' holdings in financing its routine operations. Planning for Working Capital, which in its simplest sense, is the extra monies the firm has available to finance operations until stocks and/or accounts receivables are realised, poses great challenge for management of business enterprises. Working Capital management requires making decisions on the amount and composition of the current assets holdings and the means of financing them. 126

2 Holding too much working capital relative to the level of operations or sales volume implies that the firm is overcapitalized and is unnecessarily holding fund that could otherwise be invested to earn returns. Extra funds held up in inventories, cash or accounts receivable are often left idle and can neither promote marketing activities nor hiring or acquisition of desired assets. A number of studies have provided empirical evidence that managers can improve firms' profitability through efficient management of working capital. There is however lack of harmony among researchers regarding the specific working capital variables and how each variable affects corporate profitability. Furthermore there are few studies, on sector basis, that investigated the effect of working capital management on firm profitability in Nigeria. These twin concerns are the motivating factors for this study. Shortage of empirical evidence on the effect of working capital management on firm profitability in case of the Nigerian cement sector, and lack of general agreement regarding the influence that working capital variables have on corporate profitability provided the impetus for this study. The study is therefore an attempt in filling this gap and examines the relationship between working capital management and firm profitability for the Nigerian cement production sector. This paper is intended to investigate the relationship between the variables of working capital management and company profitability with emphasis on quoted Nigerian Cement producing firms using ten years period ( ). On the basis of the background, the study formulates the following hypothesis for testing: Ho: working capital management do not have any effect on the profitability of Nigerian cement production sector. The rest of this paper is outlined as follows- Section two reviews related literature on the area under discussion, section three talks about the methodology, section four centred on data analysis and interpretation of findings and section five concludes and suggests realistic recommendations. Empirical Studies on Working Capital Management and Profitability A number of studies were conducted regarding the relationship between the management of working capital and corporate profitability. Several findings, using different data-sets, variables and methods of analysis unanimously agreed that corporate profitability can be improved through efficient working capital management. Most of these studies purport that a reduced investment in working capital would improve firm profitability. There is however, no general agreement regarding the appropriate working capital variables and the direction and magnitude of their relationship with profitability. In India, Narware (2004) studied the effect of working capital on the profitability of National Fertilizer Company Ltd of India. Using a linear multiple regression model, the study found an insignificant positive association between profitability and inventory turnover, as well as an insignificant negative relationship between profitability and debtors' turnover. Likewise in Mauritania Padachi (2006) studied the trends in working capital management and its impact on the profitability of sampled 58 small Mauritian manufacturing firms using panel data analysis for a six year period to Using pooled ordinary least square regression method, the study found no statistically significant relationship. Applying a fixed effect method however, the same study 127

3 reported insignificant positive association between inventory days and the cash conversion cycle with profitability. The relationship between debtors' turnover and profitability was however significant and negative. The study also found an increasing trend in the short-term component of working capital financing. In Pakistan, Raheman and Nasr (2007), studied the impact of average collection period, inventory turnover, average payment period, cash conversion cycle and current ratio on the profitability of a sampled 94 Pakistani firms listed on the Karachi Stock Exchange for a period of six years. Using Pooled least squares regression method, they found strong negative relationship between firm profitability and the variables of working capital management, thus managers can create value by reduction in the cash conversion cycle. Coming back home, Kantudu and Nyor (2008) studied the effect of working capital on corporate profitability, specifically of firms in the Nigerian healthcare industry over a ten-year period. Using Pearson's correlation coefficient, the study reveals that shorter cash conversion cycle and lower current ratio can improve firm profitability. Likewise, Nazir and Afza (2009) investigate the relationship between firms' profitability and working capital management using the panel data set for the period of 204 sampled non-financial firms quoted on the Karachi Stock Exchange. Their study revealed that managers can create value if they adopt a conservative policy of investing in more current assets. Investors however, attach higher value to firms that adopt the aggressive policy of financing their working capital needs from high level of current liabilities. So also in Malaysia, Zariyawati, Annuar, Taufiq and AbdulRahim (2009) examined the relationship between working capital management and firm profitability across six different Malaysian economic sectors. Using pooled ordinary least square model, the study found a significant negative relationship between the cash conversion cycle and profitability in most economic sectors. The current ratio was however, insignificantly positively related to profitability. Since no single policy is necessarily optimal to all firms, the study further conducted sectoral analyses. Results reveal that the industrial product sector reported insignificantly positive association between the cash conversion cycle and profitability. The property sector on the other hand, reported significantly positive association between profitability and the current ratio. Using ordinary least square regression model, Ramachandran and Janakiraman (2009), while studying working capital management efficiency in the Indian Paper Industry, found significant negative and significant positive associations between profitability and each of cash conversion cycle and average collection days respectively. Mathuva (2009) tested 15 years' data of 30 Kenyan firms to investigate the relationship between profitability and management of working capital. Data were analyzed using Pearson and Spearman's correlations. The study found a significant positive relationship between profits and inventory turn-over days, and negative relationship between receivable days and profitability. Furthermore, it was established that there exists a positive relationship between payment period and profitability which implies that profitable firms delay their payments. 128

4 Similarly, Falope and Ajilore (2009) looked at the effects of working capital management and corporate profitability on a sampled fifty non-financial Nigerian firms. Their study found a significant negative relationship between companies' profits and the cash conversion cycle, and its elements. The study however, utilised panel data in a pooled regression in which time-series observations were analysed. This made the study's conclusions general which may not be suited for specific sectors of the Nigerian economy. From the developed American economy, Nobanee and AlHajjar (2009) examine the relationship between working capital management, corporate performance and operating cash flow based on a sampled 5,802 publicly quoted non-financial American firms. They employed the Generalized Method of Movement System Estimation. The study reveals that debtors' collection period, creditors' deferral period and the cash conversion cycle were all significantly negatively associated with returns. The inventory conversion period however had a significant positive impact with returns. Similarly Raheman, Afza, Qayyum and Bodla (2010), in their study on working capital management and corporate performance of Pakistani manufacturing sector, and using regression analytical tools, found significant negative relationship between profitability and each of inventory turnover and the cash conversion cycle. However, insignificant negative and positive relationships subsist between profitability and each of average collection and payment periods respectively. Gill, Biger and Mathur (2010) sampled 88 American firms listed on the New York Stock Exchange over a period of three years. Using least square regression model, the study found significantly negative relationship between accounts receivable and profitability, and significantly positive relationship between profitability and the cash conversion cycle. The association between profitability and average payment period and inventory turnover was however, found to be positive and insignificant. Hayajneh and Yassine (2011) employed the analytical tools of least squares regressions model to investigate the relationship between working capital efficiency and profitability on 53 Jordanian manufacturing firms listed on Amman Exchange Market over a seven year period to The results of the study found a significant negative relationship between profitability and the average receivable collection period, average inventory conversion period, average payment period and the cash conversion cycle. The study further revealed a positive significant relationship between the size of the firm, sales growth and current ratio on one side and profitability on the other side. Most recently, Samson, Josiah, Yemisi, and Erekpitan (2012) investigated the impact of working capital management on the profitability of 30 sampled Nigerian small and medium sized firms covering the year Using multiple regression analysis, the results suggest that managers can create value by increasing their firms' inventories and receivables turnover. Similarly, a shorter cash conversion cycle improves the firm's profitability. Ogundipe, Idowu, and Ogundipe, (2012) sampled fifty-four quoted non-financial Nigerian firms for the period Employing correlation and multiple regression techniques, they examined the impact of working capital management on firms' performance and market value. The study confirmed that there is a 129

5 significant relationship between Market valuation, profitability and working capital components. Specifically, results show that there is a significant negative relationship between cash conversion cycle, and market valuation and firm's performance. Reduction in the length of the Cash Conversion Cycle therefore will lead to realization of profit maximization objective and consequently, the firm's market value. It also found that debt ratio is positively related to market valuation and negatively related to firm's performance. In addition to the short coming of Falope and Ajilore (2009) identified above, Ogundipe, Idowu, and Ogundipe, (2012) did not examine the relationship between profitability and any of the components of the cash conversion cycle, which this study attempts to address. The findings of these studies reviewed reveal diverse outcome. Based on the above studies the common determinants for Working Capital Managements are the average collection and payment periods, inventory turnover and the cash conversion cycle, as measures of working capital management. The regular approach used by the largest part of these studies was to analyze the effect of credit risk management on any other variable, using regression analysis; the regression analysis measures the actual impact of Working Capital Management on profitability of firm. Methodology This study is conducted based on historical panel data, covering the period from 2001 to The data is analysed with a view to establishing a pattern of relationship between the study variables. This makes the ex post factor research design suitable for the study. The relationship between corporate profitability and the three variables that determine the net operating cycle, namely inventory conversion period, debtors' conversion period and payables deferral period as well as the cash conversion cycle and the current ratio is examined. The population of the study consists of the four cement companies listed on the Nigerian Stock Exchange. Table 1 below presents the four companies that make up the population of the study: Table 1: Study population S/N Company Date of Listing Authorised N 000 Capital Paid - up Capital N Ashaka Cement Plc ,500, ,313 2 Cement Company of , ,339 Northern Nigeria Plc 3 Dangote Cement Plc ,000,000 7,747,010 4 Lafarge Wapco Plc ,286,933 1,500,800 Source: NSE Fact Yearbook 2010/2011 In view of the scope of the study which spans a ten year range to the year 2010, purposive sampling technique is adopted in selecting the sample size. The sample size therefore consists of the cement companies that have been listed on the Nigerian Stock Exchange for the past twelve years. This is do ne in order to avoid the problem of missing data as the financial reports of unlisted companies are not publicly available. Dangote Cement Plc which was only listed on the Nigerian Stock 130

6 Exchange in the year 2010 does not have published annual reports that cover the scope of this study. It is therefore the only company excluded from the sample on the ground that it lacks the required data to cover the period of the study. The three remaining cement companies, namely, Ashaka Cement Plc, Cement Company of Northern Nigeria Plc and Lafarge Wapco Plc, are sampled for this study. Random-effect GLS regression was done by comparing the profitability ratio (proxy by ROA) to each of the independent variables. The independent variables of average collection and payment periods, inventory turnover and the cash conversion cycle, as measures of working capital management, were used in previous studies of Padachi (2006), Sha and Sana (2006), Falope and Ajilore (2009) and Gill, Biger and Mathur (2010), Hayajneh and Yassine (2011), with Raheman and Nasr (2007) and Zariyawati, Annuar, Taufiq and Abdul Rahim (2009) adding the Current Ratio (CR), being the traditional measure of liquidity as another variable. These are basically the key variables that influence working capital management. Variables and their Measurements The independent variables have been computed as follows: Inventory Turnover Period (ITP) = Average inventory X 365 Cost of Sales Average Collection Period (ACP) = Average debtors X 365 Sales Average Payment Period (APP) = Average creditors X 365 Cost of sales Cash Conversion Cycle (CCC) = (Inventory turnover+ Average collection) - Average payment Current Ratio (CR) = Current assets Current Liabilities In order to have an appropriate analysis of the impact of working capital management on the profitability of firms, different studies have incorporated the use of other variables which are theoretically suggested to affect firm profitability. Along the same line the present study will, in addition to the working capital variables, take into consideration two control variables relating to the companies. The two control variables relating to the companies are: Size (SZ) and Leverage (LEV), this is consistent with the works of Raheman and Nasr (2007), Dong and Su (2010) and Gill, Biger and Mathur (2010) and Zariyawati, Annuar, Taufiq and Abdul Rahim (2009). While size is measured by the logarithms of total sales of the companies,leverage is measured by the ratio of total debt to total assets The econometric model employs in the study is given as: ROA = f ( ITP, ACP, APP, CCC,CR, SZ, LEV) From this general form of the regression equation model, each designed to test one hypothesis are developed. This method of model development is consistent with the works of Padachi (2006), Garcia Teruel and Martinez-Solano (2007), Falope and Ajilore (2009) and Hayajne and Yassine 131

7 (2011). ROA = á + á ITP+ á ACP + á APP + á CCC + á CR+ á SZ+ á LEV+? Data Analysis and Discussion of Results As previously stated, the study employs regression models with the purpose of testing the hypothesis. Descriptive statistics merely presents the statistical attributes of the variables in our model. Table 2provides such statistics. All the variables were computed from the relevant balance sheets and income statements of the sampled companies. Table 2: Descriptive Statistics of Variables MEAN STD. DEVIATION MIN. MAX. NO ROA ITP ACP APP CCC CR SZ LEV Source: Generated by the researcher from the Annual Reports and Accounts of the sampled companies using Stata (Version 12). Table 2reveals that the return on assets of the three cement companies over the ten year period to st 31 December 2010 ranged from a negative return of 271% to a maximum of 79%. This means that for every one Naira worth of net investment, the industry had at worst made a loss of N2.71 and had at best earned a maximum of N0.79. Every firm in the industry could earn an average of 13% on its net investment with a high degree of risk, as returns varied at both sides of the scale by as large a margin as 62%. It took an average of 180 days to convert inventories into sales. While at some particular time, some firms in the industry were able to shorten this range to only 92 days others could not turn inventories into sales till after 303 days. It should however, be noted that only 3% of total value of inventories is invested in finished stocks, 97% comprises work-in-progress, raw materials and production consumables. The credit period the companies granted their clients averaged 33 days while they paid their creditors in 234 days on the average. Whereas their debtors could remain outstanding for a maximum of 59 days, the firms were not paying their bills earlier than 117 days. 87% of the companies' collectibles were in forms of prepayments and advances to subsidiaries, only 13% were trade debtors. On the whole, the average cash conversion cycle was a negative figure of 21 days. This means that, the firms run their operations for an average of 21 days using suppliers' funds. The current ratio statistics reveal that firms' investments in current assets covered only 108% of current liabilities with a 55% variability range. At the minimum, investments in current assets covered only 30% of current liabilities. 132

8 The Pearson correlation analysis is used here to assess the relationship between the variables of working capital management and profitability. Consistent with the view that the shorter the timelag between the expenditure for the purchase of input materials and the collection of sales of finished goods the higher the profit, suggests that there exists a negative relationship between profitability and investment in current assets. Table 3 presents the Pearson correlation coefficients for our generated data. Table 3: Correlation Matrix of Variables ROA ITP ACP APP CCC CR SZ LEV ROA ITP ACP APP CCC CR SZ LEV Source: Generated by the researcher from the Annual Reports and Accounts of the sampled companies using Stata (Version 12) Table 3reveals that inventory turnover period is negatively related to profitability as the correlation coefficient stands at a negative figure of 0.233, the same is true for average collection period whose correlation coefficient is Though the relationships are not significant, results suggest that extending the periods of converting inventory into sales, and sales into cash can adversely affect corporate returns. Correlation result between profitability and average payment period presents a highly significant negative association with a coefficient of This demonstrates that paying suppliers earlier is associated with increasing the firm's profitability. This statistic measure means that the shorter the time-lag between purchases and payments, the higher the firm's profitability. This finding is inconsistent with the traditional belief of extending the creditors' repayment period. It also shows a significant positive correlation between the length of the cash conversion cycle and returns. The relationship reports a correlation coefficient of this positive correlation suggests that shortening the cash conversion cycle reduces rather than increases firm's returns. This finding signifies that the most important aspect of working capital management is in the identification of the optimal, and not the absolute length of the cash conversion cycle. This optimum length is defined by the point at which the total holding and opportunity costs of investments in current assets are minimised. The correlation coefficient between returns and the current ratio reveals a significant positive association. It reports a coefficient of This also goes contrary to the position of most of the extant literature. 133

9 To further assess the validity of non-multi-collinearity indication revealed by the correlation matrices, the study uses Variance Inflation Factor (VIF). The following table represents the results of VIF for the variables under study. Table 4: Multicollinearity Test VIF 1/VIF (TV) APP CCC ITP ACP SZ LEV CR MEAN VIF 4.94 Source: Generated by the researcher from the Annual Reports and Accounts of the sampled companies using Stata (Version 12) From the Table 4, The VIF which is simply the reciprocal of TV range 1.16 to 7.69 and this indicates absence of Multicollinearity, likewise average VIF of all variables shows VIF shows Multicollinearity when its value exceeds 10 (Tobachnick and Fidell, 1996 as cited by Sabari, 2012). Table 5: Random-effect GLS Regression ROA Coefficients Std. Errors z P? z ITP ACP APP CCC CR SZ LEV CONSTANT R-Square: Within = Between = Overall = Probability Source: Generated by the Researcher from the Annual Reports and Accounts of the sampled companies using Stata (Version 12) In appraising the model, based on the regression result in table 5, the results show the coefficient of determinations R-square shows the within and between values of 71.74% and 85.60% which are 134

10 2 highly impressive while the overall R is 63.45% indicating that the variables considered in the model accounts for about 64% change in the dependent variables, that is profitability, while the remaining of the change is as a result of other variables not addressed by this model. In general, the overall probability is positively significant at 5%, and of the all independent variables in this study, with exception of LEV with is also is negatively significant at 10%, Thus, the model equation can be written as: ROA = â â â â â â â 7 + å The intercept of means that should all our variables in the equation add up to zero, the Nigerian cement industry will make an average loss of N15.25 per every N1 worth of net investment. The regression equation above reveals that a negative relationship exists between profitability and inventory turnover period. Each day's increase in the inventory turnover period reduces profitability by N11.60, this is in line with the findings of Shah and Sana (2006), Raheman and Nasr (2007), Falope and Ajilore (2009), Dong and Su (2010) and Hayajne and Yassine (2011) whose found a significant negative relationship, However, contradict the study of Nobanee and AlHajjar (2009) whose found a significant positive association between returns and inventory turnover period. Likewise an extra day of outstanding collectibles reduces returns by N This is consistent with the findings of Studies of Padachi (2006), Raheman and Nasr (2007) and Mathuva (2009) that discovered significant negative relationship between accounts receivable and profitability. This study however opposed Ganesen (2007) who found an insignificant positive association between profitability and average collection period. However, examining the regression coefficients reveal that the explanatory variable APP has a positive relationship with returns. This means that a day's variation in deferring payments to creditors adds N11.60 to corporate returns; the positive sign indicates that the longer it takes the firms to settle their creditors, the higher the volume of their working capital which can be used to generate returns. This validates the studies of Shah and Sana (2006), Nobanee and Al-Hajjar (2009) as well as Dong and Su (2010) reported statistically significant positive relationship between average payment period and profitability. So also N11.60 increase in returns for every day extension of the cash conversion cycle; the positive association of the cash conversion cycle with profitability is not unconnected with earlier findings that increased investment in stocks and trade debtors is consistent with improved returns. This study donate to existing literature in validating the findings in Zariyawati, Annuar, Taufiq and AbdulRahim (2009) who found a statistically insignificant positive relationship between the cash conversion cycle and profitability in the Industrial products sector of Malaysia. While discard the position of Falope and Ajilore (2009), Ramachandran and Janakiraman (2009), Dong and Su (2010) and Vijayakumar (2011) whose all established significant negative relationship between profitability and the cash conversion cycle which this study did not statistically validate. 135

11 The model also reports an increment of kobo in returns per unit increase in the current ratio. This finding is consistent with earlier findings that increased investment in current assets; inventory and trade debtors in particular, improve the profitability of the Nigerian cement company. Findings of this study agree with results in Hayajne and Yassine (2011), which ascertained a significant positive relationship between profitability and the current ratio in the Jordanian manufacturing sector; as well as Zariyawati, Annuar, Taufiq and AbdulRahim (2009) that found a strong positive association between profitability and the current ratio in the property development sector of Malaysia. In contrast, Shin and Soenan (1998) and Raheman and Nasr (2007) discovered significant negative association between corporate returns and current ratio. On the side of control variables One Naira increase in sales volume raise returns by N1.39 while one Naira increase in debt reduces returns by N0.06. Base on this result, the assumption which respectively states that the working capital management do not have any effect on the profitability of Nigerian cement production sector is discarded. The result ascertains that the independent variables (working capital management indicators) have individual and unite effect on the profitability (ROA) of Nigerian cement production companies. Conclusion and Recommendations On the basis of the reviewed extant literature and the findings of the study, results indicate that all working capital variables of inventory turnover, debtors' collection period, average payment period and the cash conversion cycle significantly affects Nigerian cement companies' profitability. One can therefore conclude that working capital components significantly contributes to the working capital management efficiency of the sampled firms. The study also ascertains that investments in working capital by Nigerian cement companies are substantial and have significant impact on their profitability. Based on the conclusions of this study, it is recommended that companies should significantly raise their level of investment in working capital; such investment in current assets should heavily be concentrated in raw materials and production consumables to improve production and turnover. In doing so, the companies must however, be careful and scientifically fix inventory levels. Inventory should be acquired just in time to produce. The Just-in-Time method is therefore recommended so that inventory carrying costs can be minimised. The companies must remain reasonably liquid enough to settle recurring expenses and purchase raw materials to enable the production process run smoothly and continuously meet customer demand. Similarly, the companies should make effective use of spontaneous sources of finances with a view to curtailing the usage of short-term loans and advances. 136

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